Monday, October 02, 2006


I know this speech was Friday, but I'm just now getting to it.

St. Louis Federal Reserve president William Poole gave a speech titled "Data Dependence" on Friday. There is something here for everyone. The following quote the key to the speech:

Once inflation and inflation expectations rise, the economy will become less stable and reducing inflation from an elevated rate will be more costly than taking the medicine now. Having said that, if inflation pressures are easing, even if only gradually, and there is a genuine prospect that inflation will return to the comfort zone, then I see no reason to accelerate the decline in inflation by maintaining a restrictive policy in the face of declining employment. Policy needs to be as disciplined as necessary to get the job done, but not more so.

I note that earlier in the speech, he described inflation as outside the Fed's comfort zone. So this emphasizes that the Fed is more concerned with keeping inflation expectations down, because once inflation takes hold, it can accelerate out of control. See the late 1970's. On the other hand, if it looks like the economy is weakening and inflation will naturally subside, there is no need to remain restrictive.

Combine that with this quote from the conclusion:

To say that policy is data dependent means that policy changes will depend on the incoming news about the state of the economy, both real growth and inflation. That the policy setting is data dependent is a good sign. It means that policy is in a range than can be considered neutral - that is, thought to be consistent with the Fed's longer-run policy objectives.

So if policy is neutral now, and it looks like inflation will subside slowly from current levels back toward the Fed's comfort zone because of weaker growth, how aggressively will they cut? Earlier, he said the Fed should not "maintain a restrictive policy," but didn't say anything about a neutral one. I think we can infer the Fed would be likely to cut, but the cutting would be less than were policy currently "restrictive." In the Q&A he said "Unless we get some large shocks, it is likely that policy adjustments will be relatively modest."

Reading this, it does seem as though Poole is starting to ready the market for cuts. But I also think he is cautioning that the Fed itrulyly data dependent, as his title suggests. The market is pricing aaggressiveve easing cycle, and this speech is certainly not suggesting any such thing.

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